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- Accounting
- Preparation of Income Statement
- Operating Expenses
Micro-course: Preparation of Income Statement
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Operating Expenses
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Video Summary: What are Operating Expenses
Operating expenses basics catch many managers off guard when budgets tighten and leadership asks why team profitability is slipping. Understanding operating expenses, the recurring costs that sustain daily business operations, helps you make smarter resource decisions and defend your budget with confidence. Learn how controlling these costs directly improves your organization's bottom line. Watch the full video on JoVE Coach to master this concept with expert-led visuals and step-by-step explanations.
- Recognize which recurring costs in your department qualify as operating expenses and distinguish them from direct production costs like Cost of Goods Sold (COGS)
- Manage your team's budget more effectively by understanding how operating expenses reduce gross profit to determine operating income
- Analyze your organization's profit and loss statement to identify where cost efficiencies are being gained or lost
- Lead cost-control conversations with senior stakeholders using the language of net margin, EBITDA, and operating income
- Structure spending decisions around their downstream impact on net income, not just immediate departmental need
- Build a cost-awareness mindset within your team by connecting day-to-day spending choices to business profitability outcomes
- Align resource allocation priorities with organizational financial targets by tracking how operating expense reductions translate to measurable profit improvement
- Navigate budget reviews and cross-functional finance discussions with greater credibility and confidence
What Are Operating Expenses?
Picture this: your organization just posted solid revenue, yet leadership is concerned about profitability. You're asked to defend your department's spending in a budget review, and the CFO wants to know how your team's costs are affecting operating income. If you're not clear on what operating expenses are and how they flow through a profit and loss statement, that conversation becomes uncomfortable fast.
This is the reality for managers at every level. Financial literacy isn't just for finance teams, it's a core leadership skill.
Why Managers Misread Their Cost Impact
Most managers understand that expenses cost money. Fewer understand *where* those costs land on the income statement and how they affect the metrics leadership actually watches.
Operating expenses are the recurring costs required to keep a business running, think administrative salaries, office rent, software subscriptions, and utilities. Critically, these are not the same as Cost of Goods Sold (COGS), which covers direct production costs. Operating expenses come after gross profit on the income statement, and subtracting them from gross profit gives you operating income.
The confusion matters because misclassifying costs, or failing to distinguish between COGS and operating expenses, leads to flawed budget assumptions, poor pricing decisions, and misleading profitability reports.
A Framework That Works: The Income Statement Cascade
Think of the profit and loss statement as a cascade, not a list. Revenue flows down, with each layer of costs reducing what remains:
1. Revenue → subtract COGS → Gross Profit 2. Gross Profit → subtract Operating Expenses → Operating Income 3. Operating Income → adjust for interest, taxes → Net Income
As a manager, your direct influence typically sits at level two: operating expenses. Every staffing decision, vendor contract, and tool subscription you approve affects operating income. When operating expenses are high relative to gross profit, net margin shrinks, and that's when leadership scrutinizes headcount and discretionary spending.
Use this cascade framework during quarterly planning to show your team how their resource requests connect to business outcomes. It reframes budget conversations from "we need this" to "here's the trade-off."
How to Apply This in Your Next Budget or Business Review
The most practical move any manager can make is to regularly review their department's contribution to operating expenses using three questions:
- What's recurring and necessary? Baseline operating costs, salaries, licenses, fixed overhead, that sustain operations.
- What's recurring but reduceable? Processes or tools that automation, renegotiation, or elimination could optimize.
- What's discretionary and low-ROI? Spend that doesn't tie back to team output or revenue impact.
This mirrors the logic behind cost-control initiatives that appear in mature organizations, where a deliberate reduction in operating expenses (even 10-15%) can meaningfully shift operating income and net margin without touching revenue at all.
Bring this lens to your next one-on-one with your finance business partner. Ask how your department's operating expenses appear on the internal P&L, and whether there are benchmark ratios leadership uses to evaluate cost efficiency. That question alone signals financial maturity, and positions you as a manager who thinks beyond task execution.
Frequently Asked Questions
Operating expenses are the recurring costs your department or organization incurs just to function day-to-day, salaries, rent, software, utilities. They don't include the direct cost of making a product or delivering a service (that's COGS). As a manager, your budget decisions directly shape these numbers, and they directly affect how profitable your team appears on the income statement.
COGS covers costs directly tied to producing a product or service, raw materials, direct labor, manufacturing overhead. Operating expenses, by contrast, keep the business running regardless of production volume, think HR, marketing, administration, and facilities. Both reduce profitability, but they appear at different points on the income statement, and conflating them leads to inaccurate gross margin and operating income calculations.
Frame it as a business literacy conversation, not a cost-cutting threat. Share how the profit and loss statement works, gross profit minus operating expenses equals operating income, and invite your team to identify one or two areas where smarter spending could improve outcomes. When people understand the "why" behind cost discipline, they engage with it rather than resist it.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a widely used measure of core business profitability, and operating expenses directly reduce it. Senior leaders and investors use EBITDA to assess operational efficiency. As a manager presenting business cases or resource requests, referencing how your cost decisions affect EBITDA signals strategic financial thinking and strengthens your credibility in executive conversations.
Every headcount request adds to operating expenses, which directly reduces operating income. Going into a budget review with clarity on how your team's total cost sits within the broader P&L, and what revenue impact or cost savings that headcount enables, gives you a defensible, data-driven argument. Framing it as "this role reduces a bottleneck that costs us X per quarter" is far stronger than "we're overloaded."
Not at all. Understanding operating expenses doesn't require an accounting background, it requires curiosity and a willingness to connect your day-to-day decisions to business outcomes. Start by asking your finance partner to walk you through your department's section of the P&L. Most financial concepts become intuitive quickly once you see them applied to your own team's numbers.
Managers who understand how their decisions affect operating income and net margin earn greater trust from senior leadership, and gain more autonomy over budget decisions as a result. It also makes you a more effective advocate for your team, because you can translate resource needs into business impact rather than operational preference. Over time, this financial fluency is a key differentiator between managers who execute tasks and leaders who shape strategy.
The logical next step is understanding how to read and interpret a full profit and loss statement, including revenue recognition principles and how gross margin percentage is calculated. From there, developing comfort with EBITDA analysis and multi-step income statement structures will give you a complete picture of how management decisions translate into financial performance. These skills compound quickly and make every planning and review conversation more productive.
Introduction of the Balance Sheet explores a complementary area of Accounting, while Operating Expenses focuses on the specific concept covered in this video. Understanding both helps you build a stronger foundation in Accounting.
A basic understanding of Gross Profit is helpful before diving into Operating Expenses. If you are starting from scratch, the Preparation of Income Statement series builds knowledge progressively, so beginning from the first video requires no prior background in Accounting.
The ideas in Operating Expenses show up in everyday Accounting contexts, often alongside concepts like Introduction of the Cash Flow Statement. This video connects the theory to practical situations you may encounter in coursework or exams.
After Operating Expenses, the natural next step is Depreciation and Amortization Effect in the Preparation of Income Statement series. Following the playlist in order helps concepts build on each other without gaps.
The Operating Expenses video runs for 1 minute, so you can cover the core concept in a single focused study session without needing a long block of time.
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